The Government, power and baked beans

So far the Minister of Energy is happy to see domestic prices match the cost of electricity from new power stations. That’s not pricing based on what’s fair or on current supply and demand. It’s about the higher cost of new generation paid for by domestic consumers. This gives companies even more profit with asset values rising ever higher. And the Government gains directly as two thirds shareholder of generation assets.

How has this situation happened?

In the early days of market pricing, the Electricity Corporation was fond of telling consumers that electricity was just another commodity, no different from baked beans. Few people realized that New Zealand had already changed the laws to make that true. The Commerce Act 1986 extinguished the centuries-old concept of “essential service”. Electricity supply is now treated as if it were as competitive as baked beans.

Overseas, domestic electricity prices are regulated, for good reason. “Essential services” should be supplied as securely as possible, and at a reasonable price. New Zealand is probably unique in that its Commerce Act extinguishes that concept. Instead, New Zealand companies with market power are exploiting that strength to the full in order to maximize their profits.

Two classes of consumer

The electricity market effectively creates two classes of consumers – winners and losers. Large ‘competitive’ consumers get to drive their prices down, by negotiation, to the bare minimum needed by companies to meet their running costs. Meanwhile, domestic consumers get charged for the companies to meet their revenue requirements.

The problem is compounded because each retailer also runs power stations and builds new ones. If prices are so high they can build new power stations at will, they can increase their asset values at will The surplus generation drives wholesale prices down, so their profits don’t seem unreasonable.

The different generators will have market power at different times – whenever any has market power, they will withhold supply and drive spot prices higher – sometimes extremely high – just to take the profit.

Shortages and surplus – managed for security of supply, or profit?

There is considerable excess power station capacity today - more than is needed to keep supply security at peak times and in dry years. To be economically efficient, the capacity should be 780 MW higher than the forecasted peak demand. It is now 900 MW, and will remain so for the foreseeable future.

The capacity of power stations to generate electricity even in the driest years should be around 17% higher than the forecasted energy (kilowatt-hour) demand. It is now 25% and expected to increase.

A secure electricity system needs excess capacity in lines networks also. There is now a shortage of transmission. The loss of half the Cook Strait link was directly responsible for very high spot prices in 2008, causing high profits to most generators. But Transpower intends to not only restore that link, but to build new transmission lines that favour large-scale renewable energy projects over competing small-scale distributed generators.

Local lines pricing proposals, now under consultation, confirm the principle of “Ramsey pricing” which charges the highest prices to the most captive consumers.

The electricity supply chain includes fuel for thermal generation. Even here, opportunities to withdraw supplies and increase prices are being exploited.

Gas fields that could supply flexible generation to constrain generating costs at peak times and dry years are being contracted instead to export petrochemical industries. This earns foreign exchange, but it does not support New Zealand businesses or consumers.

New Zealand’s cheap Kapuni and Maui gas fields are practically empty. Mid-price gas from new fields could last only ten years or less, if export petrochemicals industries are able to expand as much as they would like. Methanol production now uses two thirds as much gas as electricity generation, but the company, Methanex, would like to double its gas use.

The result of present policies will be to drive New Zealand to import high-priced liquefied natural gas – or if we strike it lucky, to find another huge gas field and export the gas. In either case, New Zealand’s gas supply is likely to be tied to the ever-increasing world price of gas.

As happened to milk and cheese prices during the dairy boom, electricity prices will rise to international levels.